Monday, December 22, 2014

Commie commie commie commie commie K-Keynesian

Boy, do people like arguing over whether "Keyneisanism" is right or wrong.

I suspect that much of the motivation for John Cochrane to write this latest blast comes from his ongoing personal feud with Paul Krugman, generally acclaimed as the champion of "Keynesianism". Of course, the Wall Street Journal eats it up, since to most WSJ readers, "Keynesian" is a code-word for "commie" (thanks, Friedrich Hayek). The result of these two forces is an article which has a few good points buried deep inside it, but which is mostly wrong.

No government is remotely likely to spend trillions of dollars or euros in the name of “stimulus,” financed by blowout borrowing.

Sure, but that's always true. Then when the crash comes, "everyone's a Keynesian in a foxhole," as Robert Lucas said. A few weeks later and everyone is back on the austerity bandwagon. This is a time-stationary process, dude. Fiscal stimulus ain't dead, it's pinin' for the fjords.

Keynesians told us that once interest rates got stuck at or near zero, economies would fall into a deflationary spiral. Deflation would lower demand, causing more deflation, and so on.

Well, that's a good point! Where IS the deflation? When you have to patch up a theory after every contrary fact, you get a degenerating research program. See also: Every other macroecnomics research program.

Our first big stimulus fell flat, leaving Keynesians to argue that the recession would have been worse otherwise. George Washington’s doctors probably argued that if they hadn’t bled him, he would have died faster.

By what measure did the stimulus "fall flat"? Arguing about macro counterfactuals may be a mug's game, but a Booth Business School survey of economists found that 92% thought the ARRA lowered the jobless rate. Check out the list. That's an awful lot of well-respected doctors saying bleeding worked. Maybe they're all wrong! I wouldn't be surprised, given how little we really understand macro.

With the 2013 sequester, Keynesians warned that reduced spending and the end of 99-week unemployment benefits would drive the economy back to recession. Instead, unemployment came down faster than expected, and growth returned, albeit modestly. The story is similar in the U.K.

The Phillips curve failed to understand inflation in the 1970s and its quick end in the 1980s, and disappeared in our recession as unemployment soared with steady inflation.

We'll always have Paris.

Hurricanes are good, rising oil prices are good, and ATMs are bad, we were advised: Destroying capital, lower productivity and costly oil will raise inflation and occasion government spending, which will stimulate output. Though Japan’s tsunami and oil shock gave it neither inflation nor stimulus, worriers are warning that the current oil price decline, a boon in the past, will kick off the dreaded deflationary spiral this time.

This is a good point! Liquidity trap models with all those paradoxes are hard to square with reality. though Japan's growth did certainly rise after the 2011 tsunami and has been rising faster than America's since, and they've switched from deflation to inflation, so that might not have been the best example. Generally natural disasters lead to a growth boom due to rebuilding, though you don't need a liquidity trap model to get that.

I suspect policy makers heard this, and said to themselves “That’s how you think the world works? Really?” And stopped listening to such policy advice.

Well I suspect policymakers would be caught dead in bed with Siamese twins before they'd open up a New Keynesian DSGE paper and try to work out its implications, but hey.

Keynesians tell us not to worry about huge debts

Except in, say, Krugman's paper with Eggertsson, which is all about how debt is baaaad. I guess Cochrane means government debt. But I have heard self-identified Keynesians say that government debt isn't as bad as private debt after a recession, and that governments should run deficits in busts and then do austerity in booms. Is that crazy?

Stimulus advocates: Can you bring yourselves to say that the Keystone XL pipeline, LNG export terminals, nuclear power plants and dams are infrastructure?

I bet they could...

Can you bring yourselves to mention that the Environmental Protection Agency makes it nearly impossible to build anything in the U.S.?

This is not necessarily a good point, but it is closely related to a very good point, which is that infrastructure costs are weirdly high in the U.S., and environmental review is part of that (but it's local NIMBY landowners, not the EPA).

...Wait, what did this have to do with Keynesians? Oh, yeah, I forgot. Commies, etc.

Now you like roads and bridges. Where were you during decades of opposition to every new road on grounds that they only encouraged suburban “sprawl”? If you repeat in your textbooks how defense spending saved the economy in World War II, why do you support defense cutbacks today? Why is “infrastructure” spending abstract or anecdotal, not a plan for actual, valuable, concrete projects that someone might object to?

COMMIES

Keynesians tell us that “sticky wages” are the big underlying economic problem. But why do they just repeat this story to justify inflation and stimulus? Why do they not advocate policies to undo minimum wages, labor laws, occupational licenses and other regulations that make wages stickier?

If I recall correctly, Keynesians think getting rid of sticky wages in the middle of a recession is bad. Also if I recall correctly, if you take sticky wages out of a New Keynesian model, you still get a recession when a bad demand shock hits, the recession just reduces people's hours instead of sending them into involuntary unemployment.

Inequality was fashionable this year. But no government in the foreseeable future is going to enact punitive wealth taxes.

Wait, how is this related to stabilization policy? Besides COMMIES, I mean.

So here is my assessment of Cochrane's column:

New Keynesian models do indeed have lots of big holes in them. But most of the things Cochrane characterizes as "Keynesian" (now say that 10 times fast!) seem like things he read Krugman write in a blog post.

I'm sure Cochrane does really, honestly believe that self-identified Keynesians are a bunch of, essentially, commies. Which means that when he says "Keynesians", he's not thinking of Bob Hall, Emi Nakamura, Jordi Gali, or Roger Farmer. But maybe he should.

Cochrane really really really doesn't like Krugman. Krugman's name is never mentioned, but it's clear who this article is aimed at. The feud is getting out of hand!

The WSJ editorial page readership seem mentally stuck in the 1970s. Or at least, some of them do. We live in a Malmendier & Nagel world.

78 comments:

I have never seen such an elaborately constructed straw man receive such a thorough thrashing as in that article. While newspaper columns are not the best forum for substantive debate, Cochrane really does himself and his ideas a disservice by lowering himself to that.

Your post is very good as usual. I'd add a couple of things. First, exactly which Keynesians predicted that sequestration would cause a recession. I think that as a matter of good editorial policy, names with citations in support of all such claims should be demanded (I am not saying the WSJ must publish the names, just that a competent editor should demand that the author prove that the author can name such names).

I note *again* that, there is no puzzle to Keynesians about why sequestration wasn't followed by a marked change in the growth path of GDP (let alone a recession). The reason is that sequestration did not cause a marked change in the path of US G -- real government consumption and investment.

http://angrybearblog.com/2014/12/on-smith-on-cowan.html

The Phillips curve was never Keynesian doctrine. The prominent Keynesians used expectations augmented Phillips curves which fit the data from the 70s and 80s well. The end of the US inflation included a huge recession. This fits the Keynesians story and not at all the Lucas supply function or RBC stories. In contrast, in Europe, the disaster which followed disinflation was almost as far from predictions based on New Keynesian models as from those based on new classical models. Cochrane is relying on false claims about intellectual history. To many links but google James Forder Oxford.

Or again, names and cites. He will not be able to cite a prominent Keynesian who said the expectations augmented Phillips curve is stable, because no such person exists. I count Phillips as a prominent Keynesian. They don't have Paris and never really did.

I'm mostly on your side on this one. Krugman is sometimes a bad spokesman for Keynesian theory. After all he is a bit of a commie, or at least he seems to always be on the side of higher taxes and public spending, and he wears tweed jackets with elbow patches and writes ardently about "workers." And so many other reasons. But Cochrane is a much worse spokesman for critics of Keynesian theory. So many of his stabs in this article are so dull-edged I assume Krugman must feel like he's being attacked with the comfy pillow.

As you acknowledge he has a good point on "where's the deflation?", and that's actually a stab at New Keynesian theory not just at Krugman.

Also I think he has a good point on the sequester, which you misunderstood and failed to parry by bringing up Japan's tax hike. The underlying point is that cutting the deficit can redirect saving to private investment. That's not countered with an example of a big consumption tax hike that proportionally reduces real output. The usual Keynesian skeptic would say that consolidation is always best done through spending cuts not tax hikes.

Also your point about the12.7% GDP contraction in 1945 isn't a very good one. I don't know off the top of my head what exactly the Keynesians predicted then, but the huge drop in GDP as armament production wound down was not a depression. That was glorious relief from being forced to throw huge amounts of resources into things that brought no enjoyment. By bringing it up you seem to go along with Krugman's practice of treating GDP as some kind of God-given measure of national well being and economic health. Which I think technically makes you a commie.

Also I got a nice chuckle being reminded that New Keynesians actually put forward a theory that demand shocks caused recessions. Recessions are caused by ... recessions! And we've got a model that shows how! What a wonderfully useful bunch.

I think you may be misreading them. Demand = supply. A demand shock is a supply shock.

But I'm not giving any credence to RBC. The point I'm really making is that the vast majority of modern academic business cycle theory does not concern itself with what causes business cycles. Both New Keynesians and RBCers assume recessions are caused by some mysterious unpredictable "stochastic" shock. Their models are only concerned with certain details of how the recession plays out once such a shock has inexplicably occurred (eg, does it cause unemployment or reduction of hours?)

Tom. Demand = supply is an equilibrium concept. To simplify: In RBC models the quantities are determined by the supply curve and prices by both supply and demand. In NK model both quantities and prices are determined by supply and demand curves. There's a big difference which mtters a lot for policy analysis.

@Math - Demand = supply is an identity by definition. Again, I'm not defending RBC theory or models. I think what you mean is that in some RBC models a stochastic nominal demand drop is entirely absorbed by evenly spread deflation and does not cause any real demand drop. Of course that's very silly.

@billy - Thou makest no sense. Want to try to explain your point? Mine is that classical liberals predict that public spending cuts won't hurt growth, because cutting public spending frees resources for private activity, and also predicts that big consumption tax hikes do hurt growth. So Noah's use of Japan's tax hike as an example that supposedly contradicts what classical liberals predicted about the sequester doesn't hold water.

Personally I think any austerity obviously cuts short-term growth, and cutting effective public spending during a crisis is usually harmful and short-sighted unless the state really is close to insolvent as in say Greece. But cutting any ineffective public spending will always be better in the longer run, and if it takes a crisis to make such cuts politically possible, don't miss the opportunity.

Well, you apparently have your own special definitions. Among normal people, supply is the volume of goods and services sold, and demand is the volume of goods and services purchased. And they are by definition always equal.

Tom: Actually, those are not the usual economic definition of supply and demand.

E.g. http://economics.about.com/od/supply/p/supply.htm: Supply is "the total quantity of a good or service that is available for purchase at a given price." Similarly, demand would be the quantity that people are willing and able to buy at a given price. Needless to say, those do not need to be equal, and are dependent on price and time.

Supply=demand is an assumption that need not be true in all times and places, and indeed it isn't. Anytime there's a waiting list for a product (e.g., a Tesla), demand exceeds supply, and vice versa if product is sitting on the shelf and not selling.

Does the article in the WSJ use the word commie. Or is it just introduced in the post by yourself. I think that to think Cochrane thinks that Krugman is a commie is just nuts. There is a paranoia on the right that thinks everyone to the left of the neo-liberal right is a commie. But there is also a paranoia on the left that thinks that everyone on the right, not even the neo-liberals, think Keynesians are commies.

If you read comments in blogs, you soon see that everyone to the Right of Obama (i.e. the far-far-right) thinks that Obama and everyone to the left of Obama is a communist.

Maybe Cochrane is smarter than the actual blog commenter -- Noah seems to think so despite the idiocy Cochrane seems to spew in the WSJ -- and doesn't really believe that Obama is a communist. But the choir who Cochrane is preaching to certainly does believe that Obama is a communist. And Krugman is way, way left of Obama.

I am not a trained economist. I do know a little about science and the scientific method though.

You guys don't get to do clean experiments in lab conditions. Therefore your results are fuzzy, and open to interpretation. Then the politics creep in, and people interpret the 'results' the way their politics tell them to.

Two interesting observations about this:

1. mankiw was all for stimulus in 2001, when he worked for bush the dumb... Not so much now. I wonder why....

2. A lot of congress people and others don't believe in Keynesian hypotheses, don't think the gov't can create jobs. Yet, they all want military bases and gov't research labs in their districts.....

His feud with Krugman won't end because Cochrane will never engage with IS-LM; he will wait for it to die out; he already wrote the autopsy.

Basically, Krugman says that understanding IS-LM is a fantastic way to gain many many insights and to avoid many many pitfalls about economics. Krugman isn't opposed to new models or new ways of modeling. He likes Woodford's paper, and here he is doing New Keynsian himself in 2008.

Cochrane's point of view is scientific calculations with equations. He wants dynamic equations not static illustrated pictures or sketches with lines and arrows, storytelling, and hand-waving. He wants graphs vs. time. It's like, why watch a silent movie when we have sound? It's like he just feels that IS-LM is to economics as 4 humors is to medicine ("Hippocratic Medicine" would mean balancing the 4 humors just as "Keynesian Economics" would mean equilibriating IS and LM). Cochrane ain't interested in IS-LM at all.

Cochrane has said:

(1) "Keynesian" means ISLM-ASAD.

(2) "Keynesian" and "New-Keynesian" are as different as Ptolemaic and Copernican astronomy. Yeah, both are about the motion of the stars, but that's it.

(3) "New-Keynesian" DSGE (Dynamic Stochastic General Equilibrium) models are much in vogue, but have really nothing to do with static Keynesian ISLM modeling. Many authors would like it to be so, but when you read the equations you will find these are just utterly different models.

Seriously on commies, it's not really possible to separate the Keynesian vs non-Keynesian debate from the debate over the appropriate scale of public spending and investment. Keynesians will always accuse non-Keynesians of hijacking recessions to reduce the public role in the economy in the name of austerity, and non-Keynesians will always accuse Keynesians of hijacking recessions to increase the public role in the economy in the name of stimulus. And with some exceptions like Mankiw and Taylor, Keynesians do generally favor bigger public roles in the economy.

I thought the 70's was a bad example of anything because of Nixon taking the dollar off of gold and Volker doing massive, if not punitive, interest rate adjustments?

In any case, I don't care which way we go as long as it ensures the average human can eat, have a roof over their head, have decent medical care, and retire with some dignity. From what I can tell for all of their rhetoric against Keynesians, what they describe of the ideal end game does not involve any of that. It only involves "those that deserve it" getting that stuff, and much more.

Subsequently it seems pointless to me to argue what the best economic methodology is when you're not talking the same end. The Keynesian end (Commies!), even if wrong, is one aimed at benefiting all, whereas the anti-Keynesian end (Fascists!) is only for benefiting the few. Since my hope is a world that is good for all (and I am even willing to allow some rich in that equation, as long as the rest are left a bone), why should I even consider their argument?

To put this another way - when Reagan was president, the argument was what framework would best benefit the middle class. Now the argument has shifted to what produces the best well, "moral", outcome screw the middle class. The conservative argument is the most moral outcome is where the most deserving get what they deserve, whereas in progressive circles, the most moral is what most benefits the greatest number of people (or at least it should be!).

It would be a major step forward to simply return to, "what benefits the middle class the most", but as power has shifted so has the focus. In the 70's we wanted to return to the proverbial 50's (outside of taxes of course!). Once they twistedly got there (tax cuts on a wave of "moral majority"), then they wanted to move back to the Gilded Age. Next stop, serfdom.

"The conservative argument is the most moral outcome is where the most deserving get what they deserve, whereas in progressive circles, the most moral is what most benefits the greatest number of people (or at least it should be!)."

Cochrane's blast is a substance-free, stream-of-consciousness screed wishing for the rapid cremation of Keynes, not an rational autopsy at all, and anyway Keynes's ideas are very much alive: Government should spend on infrastructure now (during the bust) while capital and labor are idle, and government should pay down/off the limited temporary debt, if any, when the economy turns around (during the boom). Also, it's long past time for Cochrane et al to get the Keynesian joke that the Austrian school's strident recommendation of gold-mining is far more wasteful and nonproductive than anything a Keynesian would actually seriously suggest.

So Noah, repeated mentions about infrastructure costs in the US and all you have to show for it is a crappy editorial with some bullet points? I'd think you'd have the tools to do a bit better, like quantifying some of the stuff on your list. Step up your shit.

As Farmer pointed out, both classical and neo-Keynesian models assume the economy is self-correcting. So we've had 6 years of misery and the economy finally might be drifting back to a 100+ year long-term trend. And Cochrane thinks this this disproves Keynesian economics. Oh, and no deflation. He's just pissed off that Krugman called him, Lucas, and Fama out when they said gov't spending has no effect under Ricardian equivalence. The op-ed was more of a tantrum than a screed. He's a tool. But a well paid one.

I guess conservatives never learned anything from the Great Depression and how Keynesianism saved capitalism. They don't understand when people are without bread and shelter, they will turn to Leninism instead.

Cochrane is also quite disingenuous in describing Stiglitz' Vanity Fair article. He also gives no link. It is hardly fair to misrepresent Stiglitz as saying that poor people are talking on too much debt because they see rich people living lavish lifestyles beyond their means. That is not what Stiglitz said.

"Booth Business School survey of economists found that 92% thought the ARRA lowered the jobless rate."

Yes! Like Harald Uhlig, right?

"We quantify the fiscal multipliers in response to the American Recovery and Reinvestment Act (ARRA) of 2009. We extend the benchmark Smets-Wouters (2007) New Keynesian model, allowing for credit-constrained households, the zero lower bound, government capital and distortionary taxation. The posterior yields modestly positive short-run multipliers around 0.52 and modestly negative long-run multipliers around -0.42."

I guess how you phrase the question matters. I notice you ignored the much more useful question below, asking whether or not it's net positive for the economy. Without weighting for "certainty", you get 46%. Which makes more sense, honestly. Weighting by certainty just has the tendency of putting more weight on the extremes, because how can you be certainly uncertain? (Strongly agree, agree, and strongly disagree were the only ones who went up) But even if you use the weight system (way to open up to ideology, ideologues certainly are very certain they're right) you get 60%.

"But didn't a 3% sales tax hike send Japan spiraling into recession? Oh, the competing anecdotes! WHO DO I BELIEVE??"

How are those even contradictory? You can believe them at the same time. I'm sure he does.

"Well, you know, except for that 12.7% fall in GDP in 1945."

Oh, great. Just like switching Russia towards an industrialized country made it appear more productive than it was, and hence why an economy based on it suffered so much when it ended. We could all get jobs that make neo-pets, and the moment we stop I guess we'll all be unemployed. Right? Forget the boom afterwards while people readjust.

I thought an extended downward deflationary spiral required an extended 'Minsky moment'. Tarp/QE probably don't qualify as standard Keynesian policy but having the Fed buy worthless loans from banks, at face value did end the Minsky collapse.

Hello. I'd like to point out there's a new AS/AD model of the Italian economy, here: https://ideas.repec.org/p/ais/wpaper/1405.html , which shows a better interpretation of the Italian slump caused by the Eurozone. Enjoy the reading.

In a similar regard, what's up with your attacks on Mankiw? At least Mankiw is an objective and civil-acting adult. Definitely an area where Cochrane, Krugman, and yourself could learn a great deal from. Noahpinion is a Mankiw-EconoTroll.

Are we talking about this Mankiw? http://krugman.blogs.nytimes.com/2009/08/28/heredity-environment-justice/?apage=2#comments (Linking to Krugman's call-out instead of the original version because I refuse to give pagerank to racist drivel.)

The feud is insane. Cochrane says he's in favor of deficit-raising countercyclical fiscal policy "for simple tax-smoothing, consumption-smoothing, and social-insurance reasons" as well as "debt financing of 'infrastructure' or other genuine investments. If the project is valuable, do it. And recessions, with low interest rates and available workers, are good times to do it." And here Cochrane says that he believes MV=PY "has to go out the window."These are Krugman's mainpoints, to which Cochrane is apparently in complete agreement. I'll bet there's a lot more agreement to find.

The feud is silly, silly, silly. So much tempestuous anger from Cochrane and scathing disappointment from Krugman.

Cochrane defines the argument as being about whether "additional spending -- whether needed or not -- raises output and general welfare." Similarly Cullen Roche, agreeing with John Taylor, defines the argument as being about "the effectiveness of discretionary countercyclical policy intervention in the economy."

The key words here are additional, needed, and discretionary. And these words describe politics not economics. Every time government decides on a project, some people will vote no thinking the project itself or its NPV isn't acceptable, that it's additional, unnecessary, discretionary, and therefore wasteful and improper, while other people will vote yes thinking the project itself is necessary and its NPV is proper, and therefore it's appropriate investment.

What we're left with is a joke by Keynes that Cochrane refuses to get. The joke is that digging for gold to use as money is a waste in a country with fiat money. The point of the joke is that lots of things are far more worth doing than mining for gold to use as money. Cochrane continues to interpret the joke as a serious argument by Keynes that government should waste money. "Waste money to make money!" is what Cochrane hears, but that's not the Keynesian message.

No, Keynesians don't want broken windows for people to fix, buried dollars for people to mine, new wars for people to fight, natural disasters for people to rebuild, alien invasions for people to fight, or wasted waste for people to waste.

Keynesians want appropriate (not additional or discretionary but necessary and proper) countercyclical fiscal policy including both automatic and nonautomatic measures. When capital and labor are idle, a lot more necessary projects become proper.

Here's Cochrane's response to my assertion (basically the last two paragraphs above):"Sorry, that's just price = present value, which anyone agrees with. Even my anti-stimulus opeds that Krugman keeps flogging around say that low interest rates, low prices and available contractors makes more projects have positive present values. What makes an argument 'Keynesian' is precisely the proposition that we get a multiplier effect out of completely wasted spending."

The main disagreement is in the definitions of the words "stimulus" and "Keynesian": Cochrane defines stimulus as waste and Keynesian as waste-makes-haste. Krugman defines stimulus as priming-the-pump and Keynesian as priming-makes-pumping.

But as long as we don't use those words, Cochrane and Krugman have the exact same policy prescription: Government should now, because interest rates are low and unemployment is high, undertake more genuine infrastructure improvement projects -- ones that reduce unemployment and actually improve infrastructure -- and finance them with debt. And government should, when the economy improves and unemployment goes down, undertake fewer such projects and finance them with revenues.

The Keynesian position is that recessions are caused by a shortage of nominal cash flow. The solution to recessions is therefore to increase the nominal cash flows until the recession goes away.

The policy implication here is that while there is unemployment in the economy the onus is on the opponents of any given outlay to point to *actual harms* which the proposed outlay would cause, and which outweigh the benefits, including the benefit of increasing nominal cash flows. Only once the economy is operating at full capacity does the proponent of any given public outlay need to justify that the proposed spending is not "wasteful."

Because *definitionally,* while there is unemployment in the economy there is no such thing as *wholly* wasteful spending.

For Cochrane to hide behind "wasteful" spending is hence either anti-Keynesian pseudoscience or a nakedly bad faith argument.